4 1 reading 17 understanding business cycles pdf

LOS Economics • Topics in Demand and Supply Analysis • The Firm and Market Structures • Aggregate Output, Prices, And Economic Growth • Understanding Business Cycles • Monetary and Fiscal Policy • International Trade and Capital Flows • Currency Exchange Rates LOS LOS Describe the business cycle and its phases Business cycle is fluctuation of GDP over time • Alternating periods of expansion and recession Expansions: Increases in economic output Recessions: Decrease in industrial production, personal income, employment, and sales • Cycles generally last from to 12 years Varies greatly over time LOS LOS Describe the business cycle and its phases Business Cycle Phases Expansion a) Growth of econ activity b) Rising wages, prices, and employment levels Peak a) Growth rate peaks b) Economy reaches productive capacity Contraction a) Economic activity slows b) Employment drops, overall production declines Trough a) Negative trend levels off LOS LOS Describe how resource use, housing sector activity, and external trade sector activity vary as an economy moves through the business cycle Expansion • Low rates encourage business investment and allow financing for large purchases like housing • Employment picks up as production increases • Wage and employment growth increase consumer spending Peak • Economic growth rate flattens out • The economy is at maximum employment • Inflation concerns cause the consumption rate to slow LOS LOS Describe how resource use, housing sector activity, and external trade sector activity vary as an economy moves through the business cycle Contraction • Purchasing starts to slow • Inventories build quickly as demand falls, so companies cut back on hours and lay off workers • Increasing unemployment further decreases consumer demand Trough • Lowest level of economic growth/contraction • High unemployment and low levels of business spending • Expansionary monetary policy encourages new investment LOS LOS Describe theories of the business cycle Several conflicting theories of how business cycles work and how government intervention affects them: Models with Money • Believe inflation is the result of the business cycle • Monetary policy necessary to counteract the impacts of inflation on spending New Classical School • Economic growth is based on the rational expectations of economic agents • Government interventions are not effective LOS LOS Describe theories of the business cycle Neoclassical and Austrian Schools • Free markets will reach equilibrium without the need for government interference • Forces of supply and demand will moderate large swings in the business cycle Keynesian and Monetarist School • Market forces are not enough to combat large economic swings • Spending is necessary to keep economy growing, so government spending during recession is needed to offset loss of private sector spending LOS LOS Describe types of unemployment and compare measures of unemployment Unemployment is when willing and capable workers are unable to find jobs Three Primary types of unemployment: Structural • No longer demand for a specific type of worker (Telegram Operator) Frictional • Workers changing jobs or transitioning from one to another • Mismatches based on location or skills Cyclical • Based on business cycles LOS LOS Describe types of unemployment and compare measures of unemployment How can we measure unemployment? • Unemployment rate: Percentage of people in labor force that want a job but can’t find one • Payroll Employment: Monitors changes in total payroll growth/shrinking over time LOS LOS Explain inflation, hyperinflation, disinflation, and deflation Inflation • Persistent increase in price level of goods and services over time • Caused by: i Increasing money supply during slow economic growth ii Injecting large amounts of money in the economy • Advantages of inflation: i Reduction in amount of debt ii Increasing unemployment (due to nominal wage “stickiness“) • Disadvantages of inflation i Increases opportunity cost of holding money ii Discourages savings and investments LOS LOS Explain inflation, hyperinflation, disinflation, and deflation Hyperinflation • Extreme case of inflation (above 100%) • Causes: i Imbalance between supply and demand of money ii Excess printing of currency iii Lost confidence in country’s currency • Effects: i The public transfers wealth to the government LOS LOS Explain inflation, hyperinflation, disinflation, and deflation Deflation • Decrease in price level when money supply is reduced • Causes: i Reduced money supply ii Increased econ productivity grows supply of goods • Effects: i Discourages expenditures and investing ii Decreases aggregate demand Disinflation • Reduction in the inflation rate  Deflation would be an inflation rate of -2%, while disinflation would be a change in the inflation rate from 9% one year to 8% in the next LOS LOS Explain the construction of indices used to measure inflation A price index is used to track price level changes over time • Most indexes use the Laspeyres method Three steps to creating a price index: Identify kind of index: yearly, monthly, or weekly Identify basket of goods and services to include Calculate general price level of the previous and current periods The price index for the base year is set to be 100 Calculate the price index for the current year The inflation rate is the price index for the current year divided by the price index for the base year minus Example >> LOS LOS Explain the construction of indices used to measure inflation Here is part of a price index for American households What is the inflation rate for 2018? 2017 2018 Quantity Price per quantity Quantity Price per quantity Sliced bread 52 $2.59 51 $2.62 Bag of Rice 36 $0.89 38 $0.85 LOS LOS Explain the construction of indices used to measure inflation Here is part of a price index for American households What is the inflation rate for 2018? 2017 2018 Quantity Price per quantity Quantity Price per quantity Sliced bread 52 $2.59 51 $2.62 Bag of Rice 36 $0.89 38 $0.85 General price level Price index Inflation rate $166.72 $165.92 100 $165.92/$166.72 = 99.52 (99.52/100) – = -0.48% To get the general price level, multiply all terms of each year together The price index for the base year is set at 100 To get the price level for 2018, divide the price level of 2017 by the price level of 2018 The inflation rate is then simply the price index of 2018 divided by the price index of 2017 minus one LOS LOS Compare inflation measures, including their uses and limitations Consumer Price Index • Looks at basket of goods and tracks their purchase prices over time • Uses a fixed basket of goods and services, such as the Laspeyres index • Several limitations: i Bias against new products ii Bias against increasing quality of goods over time iii Bias against substitution effect for goods not in basket  The Fisher Index was created to correct substitution bias of Laspeyres Producer Price Index • Includes products at all stages of production process LOS LOS Distinguish between cost-push and demand-pull inflation Cost-Push Inflation • Caused when price increases increase costs of production and reduce aggregate supply • Increases production costs flow through to higher costs of goods and services • Increased prices could be from increasing wages or higher prices for inputs like raw materials Demand-Pull Inflation • Increase in aggregate demand outpaces ability to increase supply • “Too much money chasing too few goods.” • Supply shortfall leads to price increases LOS LOS Interpret a set of economic indicators and describe their uses and limitations Economic indicators give information about the condition of the economy and are used for determining the current state and trends of the economic cycle Leading Indicators • Intended to predict future movements of the economy • Include share prices, consumer durables, and net business formations Lagging Indicators • Only change when the economy has started following a certain pattern • Includes unemployment, interest rates, GNP, and CPI Coincident Indicators • Exist during specific economic activities • Includes GDP, retail sales, and employment levels LOS LOS Interpret a set of economic indicators and describe their uses and limitations What are the uses of Economic Indicators? • They have unique schedule for release so investors can prepare for them • They indicate the direction of the economy • Analysts use them to predict possible future investments Limitations of Economic Indicators • The interpretation can be tricky • Data are usually inaccurate/estimated • Measuring GDP is practically impossible LOS Economics • Topics in Demand and Supply Analysis • The Firm and Market Structures • Aggregate Output, Prices, And Economic Growth • Understanding Business Cycles  Monetary and Fiscal Policy • International Trade and Capital Flows • Currency Exchange Rates ... 2 018 ? 2 017 2 018 Quantity Price per quantity Quantity Price per quantity Sliced bread 52 $2.59 51 $2.62 Bag of Rice 36 $0.89 38 $0.85 General price level Price index Inflation rate $16 6.72 $16 5.92... the price level for 2 018 , divide the price level of 2 017 by the price level of 2 018 The inflation rate is then simply the price index of 2 018 divided by the price index of 2 017 minus one LOS LOS... $16 6.72 $16 5.92 10 0 $16 5.92/ $16 6.72 = 99.52 (99.52 /10 0) – = -0 .48 % To get the general price level, multiply all terms of each year together The price index for the base year is set at 10 0 To get the